by Shawn Narancich, CFAVice President of Research
Volatility: Wherefore Art Thou? Stocks have now completed seven straight weeks of trading in the new year without a pullback of 100 points on the Dow, which might not be so remarkable if it didn’t follow the last five months of 2011 where 41 percent of the trading days were marked by 2 percent +/- daily price swings. To the bulls who are enjoying a steady stream of better-than-expected economic news, a lack of hedge fund participation and still nascent retail-fund flows imply more upside potential for stocks. This week, applications for new unemployment claims hit a four-year low, inflation numbers came in below expectations and two regional manufacturing indices confirmed the expansion of U.S. manufacturing. As markets closed up 1 percent for the week, the S&P 500 is threatening to push through key technical-resistance levels.
The Big Apple The purveyor of now ubiquitous iPhones and iPads eclipsed ExxonMobil to become the world’s most valuable company, pushing through $500/share this week before suffering an acute case of vertigo. As mentioned in a previous Weekly Market Makers log, the company’s huge market capitalization is having an outsized impact on equity indices and related statistics. In this case, a 24 percent gain in 2012 has catapulted technology into the top slot for sector performance, eclipsing both basic materials and financials year-to-date.
A Rigged Market Typically, an 8 percent gain in stocks driven by better economic data would incite inflation concerns and push bond prices down and yields up; however, with benchmark 10-year Treasuries trading to yield 2 percent, losses in bonds have been modest. Why? The Federal Reserve continues to execute Operation Twist, by selling shorter dated securities in favor of longer maturity debt. This indirect monetization of U.S. debt couldn’t come at a better time, what with the Treasury now financing $10 trillion of externally held obligations. What will be interesting to see is how the Fed unwinds its nearly $3 trillion balance sheet … if and when it needs to push up interest rates by selling this debt.
Caught between a Rock and a Hard Place After the deal to sell Pringles to Diamond Foods fell through because of the latter’s accounting improprieties, Procter & Gamble quickly found a new buyer at the same price, helping complete its objective to exit the food business. Kellogg, which already owns Keebler snack foods, agreed to gobble it up for a cool $2.7 billion cash. Why pay nearly twice sales for this old grocery aisle snacking staple? Largely to avoid the fates of competitors like General Mills and J.M. Smucker Company, which both disappointed investors this week with poor earnings. Combining Keebler with Pringles’ established sales channels overseas delivers compelling distribution synergies that should enhance profitability, increase exposure to faster growing, less competitive emerging markets and reduce Kellogg’s reliance on a mature cereal category that has for years been the subject of profitability-denting market share wars.
So what’s wrong with General Mills and Smucker? Both tried to raise prices and both experienced a cold shoulder from customers. Raise prices on Smuckers jam, Folgers coffee, and Cheerios? See volumes fall. Maintain pricing to fend off cheaper private label options? See gross margins plummet. Herein lies the intractable challenge to consumer staples companies operating in mature markets where brand equity is low. It’s one of the key reasons why both Kellogg and Procter & Gamble rose on news of the Pringles deal.
Next week brings the likely European approval of a new bailout package forGreeceand related Greek debt restructuring news, as well as major retailer earnings reports.
Our Takeaway from the Week While stocks seem ripe for profit-taking, we see equities supported by the following:
- faster economic growth
- improving fund flows
- attractive valuations, and
- continued deal flow